Change of recommendation. Our expectation of slowing sales growth at Bunnings is playing out, but earnings are barely being dented. WES pointed out that it is actually a good time to be a ‘low cost’ retail offer, referring not just to Bunnings but Kmart and Officeworks as well. The company is still in development phase with lithium, but this could bring meaningful new growth within a few years. The Health division too, is expanding rapidly and has yet to benefit from the Wesfarmers touch. Underpinning the group is a rock solid balance sheet (net debt to EBITDA 1.9x) with significant headroom against covenants. The FY24 PER at 22x and small premium to market ascribes insufficient credit to the outlook for WES. We upgrade our recommendation to Hold.
FY23 results overview (vs consensus):
Net profit $2,465m vs $2,458m
EPS 217cps vs 217cps
DPS 191cps vs 185cps
Group EBIT $3,863m vs $3,830m
Bunnings. Comparable store sales growth at Bunnings of 1.8% for FY23 was slower than last year (4.8%) and even slower in 2H23 at 0.8%. Customers are still spending on home maintenance and repairs and smaller DIY projects, inferring that larger project spending is being deferred. The Bunnings store network (total 513) now includes 14 Tool Kit Depot and 116 Beaumont Tiles stores.
Kmart Group stood out for its 16% revenue bounce (Kmart 22%, Target 1.1%) and EBIT increase of 43% to $849m. A full year of the store network conversions (from Target to Kmart) contributed but with some shrinkage (theft) mentioned. Of interest, Kmart has launched its own brand (Anko) product into Canada via the Hudson Bay Company. Anko is thought to have annual sales around $6bn in Australia (Kmart total sales $10.1bn).
WesCEF. Sales of chemicals and fertilisers dipped in FY23 from last year’s peak. The main focus in this division is the development of the lithium business (Covalent) which includes the Mt Holland lithium mine (construction now completed) and the Kwinana Refinery (under construction). WES is expecting to execute some offtake agreements for lithium hydroxide later in 2023. First earnings from Covalent are slated for 1H of CY24 from the sale of spodumene concentrate where FY24 volume could be ~50kt. Capex guidance of $1.2-1.3bn (WES share) will deliver first production of LiOH in 1H of CY25.
Officeworks revenue increased 5.9% to $3.3bn in FY23 on better back-to-school trading and a NSW voucher program. EBIT increased 10.5% to $200m. Officeworks will join the group OnePass program in 1H24 although its online penetration at 33% suggests limited scope for upside.
Health. WES continues to bulk up its Health division acquiring InstantScripts and a proposed acquisition of SILK Laser Australia. The Priceline network is expanding and the wholesale division is being revamped. Across this division there are 654 stores (390 Priceline Pharmacy).
Catch was removed from the Kmart division and reported a loss of $163m EBIT, almost twice the FY22 mark. Losses are expected to continue in FY24.
Outlook. Value-conscious shoppers are trading down to lower priced retailers and products, according to WES, in response to inflation and higher interest rates. Offsetting that is low unemployment and high immigration numbers, the latter fundamentally supportive of housing construction growth.
Kmart is still trading strongly in the first 7 weeks of FY24, but WES says ‘growth has moderated’ late in FY23. Bunnings sales remain steady compared to 2H23 and Officeworks sales are in-line with last year.
Cost pressures on labour and supply chain remain elevated but WES is leveraging its scale to attain efficiency and sourcing benefits.
Lower ammonia prices will drag WesCEF’s existing businesses down in FY24 just as first earnings from the Mt Holland lithium business pops up in 2H24.
WES is guiding net capex in FY24 to $1.1-1.4bn subject to net property investment and the timing of major expansion projects in WesCEF.
Investment View
As retail spending continues to waver, consumers are biasing their spend towards value. This is playing right into WES’s sweet spot. The company is leveraging its scale to smother the cost bushfire that other retailers are battling. Suppliers are providing shorter lead times, investment in supply chain is improving efficiency and in-store productivity keeps finding new solutions to protect margins.
WES says it can keep on finding growth within its businesses such as space optimisation. This is most evident in Kmart where the bold decision to switch most of the Target stores to Kmart is paying off. Bunnings continues to evolve its broad category spread to cater for just about anything non-food in the Australian home.
WES has been trading below its average PER of 24x and in-line with the market.
Risks to Investment View
Interest rates may not remain high for as long as expected, which would boost consumer confidence and retail sales. WES’s capex for online might be larger and take longer to generate acceptable outcomes. WES has a history of acquisition (and divestment) with the most recent examples being in healthcare and lithium. There is risk involved in extending the portfolio, particularly into new businesses although WES has a strong track record, albeit imperfect, in this regard.
Recommendation
We have upgraded our recommendation to Hold.
Figure 1: WES PE Ratio
Figure 2:WES PE relative to market
Figure 3: WES divisional earnings
